The uncertainty surrounding the government’s commitment to consolidate its fiscal deficit in the budget on Friday is likely to have played an important role in the RBI’s neutral guidance

With inflation remaining high, the Reserve Bank of India (RBI) kept the interest rate unchanged for now, but made a promise that cost of borrowing will come down in future. Amidst expectations of a pause in tight monetary policy, RBI governor D Subbarao gave a firm signal that no further hardening of interest rates is required. However, the timing and the quantum of rate cuts will be determined by inflation, the governor said unveiling the mid-quarterly review of the credit policy, a day before the Union Budget.

Sonal Varma, executive director and India economist at Nomura, said, “Policy rates do need to move to a more neutral setting; the question is one of timing, and we believe that the uncertainty surrounding the government’s commitment to consolidate its fiscal deficit in the budget tomorrow likely played an important role in the RBI’s neutral guidance. Even though slow growth warrants monetary easing, the RBI decided otherwise as upside risks to inflation have risen due to higher crude oil prices, fiscal slippage, and rupee depreciation and continued suppressed inflation.”

The benchmark policy interest rate (repo rate) at which RBI lends to banks has been kept unchanged at 8.5%. The cash reserve ratio (CRR), the portion of deposits banks need to keep with RBI, has been retained at 4.75%. This rate was reduced last Friday (10th March) by 0.75 percentage points to infuse Rs48,000 crore in the system to ease liquidity.

“Recent growth-inflation dynamics have prompted the RBI to indicate that no further tightening is required and that future actions will be towards lowering the rate. “However, notwithstanding the deceleration in growth, inflation risks remain, which will influence both the timing and magnitude of future rate actions,” Mr Subbarao said, adding that suppressed prices of fuel, fertiliser and power pose risk to inflation in the economy.

The RBI said the upside risks to inflation have increased from the recent surge in crude oil prices, fiscal slippages in government finances and rupee appreciation. Inflation rose to 6.95% in February which is much above the RBI’s comfort level of 5%-6%.

According to BRICS Securities, over the last several policies, the RBI has created a small window for itself for a future rate cut. “By interlacing rate-easing talks with talks of inflationary risks (arising out of suppressed inflation and the fact that retail prices are not aligned with global commodities), the RBI, however, is smartly avoiding a policy ‘self goal’. It is likely to go in for a 25 basis points (bps) rate cut in April if the government presents a reasonably progressive and realistic budget tomorrow and if the global economy is stable over the next month,” the brokerage said in a report.

The RBI said while there is a slowdown in economy, the gross domestic product (GDP) growth in the last quarter of the current financial year is expected to be better than the previous three-month period.

Prime minister’s economic advisory panel chairman C Rangarajan said RBI will watch the inflation trajectory and the policy change will come only when there is a definite signal of decline in price rise.

India Inc said RBI should reduce interest rates in the next policy to spur economic activity.

“It is difficult for RBI to cut down rates, but industry would need to have a rate cut for investment pipeline. We should be strongly expecting a cut in the next review,” CII director general Chandrajit Banerjee said.

The RBI’s decision to keep policy rate unchanged is driven by the better than anticipated spike in growth numbers as well the rising inflation pressure on the economy.

The central bank is scheduled to announce annual credit policy for 2012-13 on 17th April.

Many analysts had expected the governor not to take any major step in the Budget-eve policy announcement.

Reiterating its concerns on the fiscal situation, which saw sharp increase in government borrowing, the central bank said “credible fiscal consolidation will be an important factor in shaping inflation outlook” which has key determinant of policy actions in the past two years.

The RBI had been aggressively hiking policy rates to tame inflation. The apex bank hiked key policy rates 13 times, totalling 3.50% between March 2010 and October 2011.

On systemic liquidity, which prompted the CRR cut, RBI said it will worsen further till 16th March with the outgo of advance tax payments by corporates.